October, 2010

Economic Policy and Poverty, and Finance and Private Sector Team

South Asia Region

The World Bank

Bangladesh Economic Update

1

Bangladesh Economic Update October 2010

Summary

Bangladesh is estimated to have grown at a healthy rate in FY10, despite the slow global

recovery and severe power shortages. Much of this growth (revised estimates put it at 5.8

percent) came from the services and industrial sectors, driven by growth in consumption fueled

by strong remittance inflows, especially in the first part of the year. In FY10, inflation rose to 7.3

percent, up from 6.7 percent in FY09, driven mainly by rising food prices. In particular, prices of

rice rose because of shortages in domestic production and rising prices in India. Monetary

growth remained high in FY10, driven by strong growth in credit to the private sector and

continued accumulation of net foreign assets by the Bangladesh Bank. On the external side,

exports weakened compared to FY09 and remittances slowed towards the end of the fiscal year

because of global economic conditions. Domestic power shortages also interrupted the

production of readymade garments. Foreign exchange reserves rose to a level equivalent to 5.5

months of imports. Overall, fiscal prudence was maintained in FY10, with the fiscal deficit

remaining at around 4 percent of GDP.

Reforms progressed in FY10, despite some setbacks. The ongoing and prospective changes in

tax policy and administration could be critical for Bangladesh’s growth prospects. There has

also been progress in reducing structural constraints to investment. There was improvement in

the institutional framework for facilitating public and private investments (Special Economic

Zones Act, Public-Private Partnership guidelines, Bangladesh Infrastructure Finance Fund).

Regulatory reforms in the capital market came as a firefighting response while, in areas of core

governance, there were setbacks (amendments to the Telecommunication Act and proposed

amendments to the Anti-Corruption Commission Act).

GDP growth is projected to be 6.1-6.3 percent in FY11. This estimate emanates largely from

higher public and private investment. However, there are several downside risks to growth in

FY11. A weaker than anticipated global recovery could dampen the recovery in exports and

further slow down remittances. Meanwhile, on the domestic front, continued power shortages

could choke growth. The downside risks may dominate the upside potential.

Recognizing the importance of reliable power for industrial growth, the government has

contracted domestic and foreign private power producers. This involves a trade off. While

providing power would help sustain growth (electricity shortages in Bangladesh have a

significant impact on production and therefore growth), it also imposes additional fiscal costs.

The additional fiscal cost of the new power agreements is estimated to be between Tk.52.4 billion

and 55.8 billion, which is equivalent to 5.6-6 percent of the FY11 budget revenue target, or about

0.67-0.72 percent of GDP. These costs will become more significant if revenue falls short of

targets. Considering the high opportunity cost of not having electricity, the objective of keeping

growth going by entering into new power agreements from costly sources is an unavoidable

short-term solution. However, making equally fast progress on implementing the longer-term

strategies for improving power supply are crucial for Bangladesh.

2

Recent Economic Developments1

Growth in FY10 has been respectable despite subdued investment Bangladesh is estimated to have grown at a healthy

rate in FY10 despite the slow global recovery and

severe power shortages. According to revised estimates,

real GDP grew by 5.8 percent in FY10. Given the slow

global recovery, severe power shortages, and labor unrest

in the garments sector, this growth performance is

noteworthy. Growth came mainly from the services and

industrial sectors driven by growth in consumption,

which contributed 4.2 percentage points (Figure 1) and a

rebound in construction activities. Strong remittance

inflows and good growth in rural non-farm activities

supported the growth in consumption, while construction

benefited from a nearly 32 percent improvement in the

implementation of the Annual Development Program (ADP) compared to FY09. Industrial growth was

supported by term credit disbursement, which increased by over 29 per cent in FY10 compared to FY09,

despite severe gas and power shortages. The services

sector also remained vibrant.

Investment continued to be one of the major

constraints to faster growth in FY10. While gross

national saving increased from 26.6 percent of GDP in

FY09 to 28.8 percent in FY10, gross domestic investment

remained stagnant at 24.4 percent of GDP reflecting both

stagnant private and public investment rates. Weaknesses

in the investment climate, rather than financing of

investment, continue to constrain growth.

Inflation rose in FY10, driven by food price increases Inflation

2 rose from 6.7 percent in FY09 to 7.3 percent in FY10, overshooting the target by 0.8

percentage point (Figure 2). After a respite of about twelve months, inflation began to rise from October

2009. In fact, inflation (y-o-y) rose every month (except March and April 2010) and reached 8.7 percent

in June 2010 (See Annex I for details). Inflation remained somewhat volatile at around 7.5 percent in

July-August 2010, due to continued volatility in food inflation.

The high rate of inflation in the second half of FY10 was driven by increases in food inflation from

0.3 percent in June 2009 to 10.9 percent in June 2010. Rural food inflation stood at 10.4 percent while

1 This brief was prepared by Zahid Hussain, Lalita Moorty, and Sanjana Zaman, with inputs from Diepak Elmer, Nadeem Rizwan

and M.Abul Basher (SASEP), under the guidance of Sanjay Kathuria (SASEP). Power sector simulations were done in

consultation with Naoko Kojo (PREMED) and Zubair Sadeque (SASDE). Oversight was provided by Miria Pigato (Sector

Manager SASEP). Ivailo Izvorski (EASPR) and Martin Rama (SARCE) were the peer reviewers. 2 Inflation/price changes are year-on-year unless otherwise stated.

5.7

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FY09 FY10 (P)

Figure 1: Contribution to Growth(Percentage Points)

GDP Growth Consumption Investment Net Export

Source: Based on BBS Data

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Figure 2: Inflation(%) Y-o-Y

General Food Non-Food

Source: BBS

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urban food inflation reached 12 percent in June. The food price index was driven, in turn, by rise in prices

of rice that account for 23.8 percent weight in rural CPI and 11.3 percent weight in urban CPI. Rice alone

contributed 5.3 percentage point to rural inflation and 2.7 percentage point to urban inflation in June

2010. The price of coarse rice in Dhaka in September 2010 was 50 percent higher relative to September

2009. Meanwhile, non-food inflation has been declining recently. After increasing from 3.7 percent in

July 2009 to 7.0 percent in December 2009, non-food inflation gradually dropped to 5.2 percent in June

2010. The rural non-food inflation stood at 5.6 percent while urban non-food inflation reached 4.4 percent

in June.3

Domestic agriculture output and world food prices – particularly price developments in India – are

likely to have a strong bearing on food inflation in the next few months. The government has decided

to import 130,000 tons of rice from Thailand, Pakistan, Vietnam and India to boost official rice stocks.4

The government has also reopened the Open Market Sales, expanded operation of the existing safety nets

programs, and increased the procurement price to provide incentives for increasing rice production. The

Bangladesh Bank has reduced the maximum repayment time of revolving loans taken against “pledge and

hypothecation” for rice purchase from 60 days to 45 days for local rice millers and from 45 days to 30

days for rice traders to ensure adequate supply.

The continuing rise in prices is of particular

concern to Bangladesh, especially in view of the

global staple price increases since July 2010. The

government is taking proactive short-term measures

to address the situation: participation in the food

grain market, expanding existing safety net

programs, and providing incentives to increase

production (paragraph 5 and Annex 1). However, the

problem also calls for longer-term measures to

improve agricultural productivity and enhance rural

transport infrastructure and market access.

Growth in money and credit remained high in FY10 Broad money increased by 22.4 percent and reserve money increased by 16 percent in FY10,

compared with 19.2 percent and 31.4 percent respectively in the previous year (Figure 3). The

increase in broad money growth was driven largely by 18.3 percent growth in credit to the private sector,

due to increased disbursement of agricultural and SME credit supported by the Bangladesh Bank‟s

refinances lines. Net foreign assets held by the Bangladesh Bank increased by 41.2 percent, compared

with 31.7 percent growth in FY09.

The liquidity overhang and asset price bubble still persist. Excess liquidity in the banking system

amounted to Tk.299 billion at end-August 2010 compared with Tk.345 billion at end-June 2010. The

stock index has risen by 125 percent in the past twelve months, ending in August 2010.

3 Food and non-food inflation declined in July in both rural and urban areas, but food inflation rose back to 9.9 percent in August

(8.6 percent in July) in rural areas while declining to 8.9 percent (9 percent in July) in urban areas.. 4 The stock of rice was around 0.72 million tons on August 21, 2010, compared with the target of 1.5 million tons.

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Figure 3: Money and Credit Growth (%)

M2 Private Sector Credit

Source: Bangladesh Bank

4

Exports and remittances slowed, and the terms of trade appear to have deteriorated After declining for much of FY10 (y-o-y), Bangladesh’s exports began rising, year-on-year, in the

second half of FY10 to achieve a growth rate of 4.1 percent for the year. The positive trend continued

in the first two months of FY11 with a growth rate of 28.8 percent. Exports of readymade garments have

grown at 1.2 percent in FY10, which is the slowest growth since FY02, when the sector experienced a

negative year. The global recession caused a drop in retail sales in Bangladesh‟s main export destinations.

During the period May-July of FY10, exports of readymade garments to the US and Germany – the two

largest export markets – declined by 4.1 percent and 7.9 percent respectively.

Total remittance inflow to Bangladesh kept growing strongly for most of FY10, but the monthly

pace started to slow, and turned negative at the end of the fiscal year. In FY10, remittances reached

US$11.0 billion, a 13.4 percent increase compared to last year. However, in the first half of FY10 (July-

December 2009) the growth rate was 22.8 percent, dropping to 5.2 percent in the second half (January-

June). Preliminary data for the first two months of FY11 (July-August 2010) show a continuation of the

downward trend, with remittance inflows declining by 0.8 percent.

With global commodity prices rising – cotton and yarn prices in particular – and prices of

Bangladesh’s manufactured exports falling, the terms of trade deteriorated. Export growth of 5

percent in FY10 was entirely volume driven while average prices decreased by about 0.9 percent. The

volume of manufactured exports increased by 5.2 percent, while the export price of manufactures

decreased by 0.6 percent. The export price of primary goods declined by 4.9 percent.

Foreign exchange reserves continued to rise. The external current account surplus rose to US$3.7

billion in FY10, over 50 percent higher than last year‟s surplus, notwithstanding the widening of the trade

deficit from US$4.7 billion in FY09 to US$5.2 billion in FY10. This primarily reflects the rise of current

transfers from US$10.2 billion in FY09 to US$11.6 billion in FY10 and a reduction in the service account

deficit from US$1.6 billion to US$1.2 billion. Together with a reduced deficit in the financial account,

this led to an increase in the overall balance of payments surplus from US$2.06 billion in FY09 to

US$2.87 billion in FY10. The surplus has led to accumulation of foreign exchange reserves (Figure 4),

currently at around US$11 billion (equivalent to 5.5 months of GNFS imports). Bangladesh maintains

half of its foreign reserves in US dollar-denominated assets, one-seventh in Euros and the rest in other

currencies.

Fiscal prudence was generally maintained The fiscal deficit in FY10 is estimated to have been the same as last year (4 percent of GDP – Figure

6). The revenue-to-GDP ratio has increased from 10.5 percent in FY09 to 11.7 percent in FY10 and the

tax/GDP ratio has increased from 8.6 percent to 9.4 percent. The increased tax revenue was driven by

higher-than-targeted growth in domestic VAT and income tax collections. Meanwhile, the expenditures-

to-GDP ratio also rose, from 14.5 percent in FY09 to 15.6 percent in FY10.

5

Although domestic financing in FY10 was one percentage point below the original budget target of

3 percent of GDP, the composition shifted towards more expensive sources. Government borrowing

through the expensive savings instruments more than tripled, from Tk.36.3 billion (net) in FY09 to

Tk.115.9 billion in FY10.5 As a result, the stock of National Savings Directorate (NSD) debt outstanding

increased from 8.1 percent of GDP at the end of FY09 to 8.9 percent at the end of FY10. The effective

interest rate on domestic debt increased from 8.7 percent in FY09 to 9.4 percent in FY10. The

government has cut interest rates on savings certificates by 1.5 percentage points to 2.0 percentage points

with effect from July 1, 2010 (Figure 7). The highest interest rate is reduced from 12.5 percent to 11

percent. The lowest rates will apply on fresh issues and renewals of saving certificates. The interest rates

are reset to align with the market, where interest rates offered to savers are much lower. This difference

led to the large increase in net sales of NSD certificates in FY10.

Economic Policies: Monetary, Exchange Rate, Fiscal and Other

Monetary policy is accommodative The monetary policy, announced by the Bangladesh Bank (BB) in July 2010 is accommodative, but

promises to be watchful of inflation. This stance gives weight to the downside risks to growth stemming

from uncertainties of global demand recovery. The Monetary Policy Statement commits to support

5 Bangladesh Bank, Major Economic Indicators: Monthly Update, August, 2010.

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Figure 6: Govt. Revenue and Expenditure (% of GDP)

Total Revenue

Total Expenditure

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Figure 7: Interest Rate (%) Movement

3 Year NSC Rate5 Year NSC RateCommercial Lending Rate

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Figure 4: Foreign Exchange Reserves (Million US $)

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Figure 5: Bangladesh: NEER and REER Indices

Nominal Effective Exchange Rate (NEER)

Real Effective Exchange Rate (REER)

Note: Increase in the index means appreciation of the currency

6

growth and promote the inclusion of agriculture, SMEs, renewable energy, and an ecological bias in

technology sectors – while being wary of the risk that such support could leak into financing consumption

and speculative investments. Earlier, the BB increased the CRR from 5 percent to 5.5 percent and

widened the open exchange positions of banks to restrain the expansion of the monetary base. Later, the

BB increased the repo rate from 4.5 percent to 5.5 percent and reverse repo rate from 2.5 percent to 3.5

percent. It should be prepared to take more of such action if inflationary pressures increase. A critical

assumption underlying the Monetary Policy Statement is that the liquidity overhang resulting from

unsterilized interventions in the foreign exchange market is nearing its end because of slowing remittance

growth and a large pick-up in imports due to increased investment and capacity utilization. If the BOP

surplus does not shrink nearly as much, the challenge for monetary policy will be to make adjustments in

the growth of net domestic assets, since it will endeavor to maintain the competitiveness of the exchange

rate and hence continue to accumulate net foreign assets.

The taka has appreciated in real effective terms The nominal exchange rate has been stable, but competitiveness of exports may be at risk. The BB

has regularly intervened in the foreign exchange market to maintain the competitiveness of the exchange

rate, curbing tendencies for excessive volatility. The nominal exchange rate was stable throughout the

year and the period average interbank exchange rate depreciated slightly by 0.6 percent, from

Tk.68.8/USD in FY09 to Tk 69.2/USD in FY10. The BB purchased US$1.94 billion in FY10 to prevent a

nominal appreciation of the taka. However, Bangladesh‟s relatively high inflation compared with its

trading partners and the BB‟s de facto policy of pegging the exchange rate to the US$ has contributed to

an appreciation of the taka in real effective terms (Figure 5). Emerging wage pressures in the economy are

likely to exacerbate the real appreciation of the taka, and further undermine the competitiveness of

Bangladesh‟s exports, if gains in labor productivity do not exceed the real effective exchange rate

appreciation.

Budget FY11: moderate expansion; ambitious revenue targets and spending increases

The FY11 budget is moderately expansionary. The overall budget deficit is projected to rise to 5

percent of GDP. The rise in the deficit is projected to be financed entirely through an increase in domestic

borrowing leading to a rise in domestic financing from 2 percent of GDP in FY10 to 3.0 percent in FY11,

while net external financing would remain unchanged at 2 percent of GDP.

The FY11 budget revenue target is ambitious, with total NBR and non-NBR revenue projected to

rise by 15.4 percent (0.2 percentage of GDP) against the government’s FY10 actual revenue

outturn. Achievement of the envisaged revenue target in FY11 will hinge on sound implementation of

the ongoing and proposed measures in reforming VAT and expanding the income tax base. The budget

increased the VAT rate on both wholesale and retail, increased advanced trade VAT rates, and has

withdrawn the truncated base for some services, simplified the price declaration procedure for VAT,

imposed VAT on e-commerce, broadened the scope of VAT collection at source, etc. The government

also committed to more comprehensive reforms through the introduction of a new VAT Act in FY11.

The FY11 budget envisages spending increases, driven by 35 percent growth in Annual

Development Program (ADP) outlays. Expenditure is appropriately focused on addressing development

and infrastructure needs, including those aimed at alleviating power shortages, with the budget allocation

for the power sector – both development and non-development expenditure – increased by 62 percent to

Tk.61 billion (0.8 percent of GDP). Aside from this, no major changes were made on the development

7

expenditure side. However, there is a block allocation of Tk.15 billion for the Padma Bridge, i.e., slightly

less than 4 percent of total ADP size. The budget also contains a modest stimulus package for exporters,

aimed at helping them cope with the impact of the global recession. The allocation for FY11 is Tk.20

billion, compared with Tk.21 billion in FY10 and Tk.34.2 billion in FY09. This is consistent with the idea

of phasing it out gradually.

Progress was made on reforms, despite some setbacks

The ongoing and prospective changes in tax policy and administration could be critical for

Bangladesh’s growth prospects. If these changes are implemented well, revenue could increase

significantly, which would help increase much needed public investment without jeopardizing fiscal

sustainability. Increased public investment, especially in infrastructure, would be an important factor in

drawing in private investment.

There has been progress in reducing the structural constraints to investment. There was

improvement in the institutional framework for facilitating public and private investments (Special

Economic Zones Act, Public-Private Partnership guidelines, Bangladesh Infrastructure Finance Fund).

Regulatory reforms in the capital market came as a firefighting response while, in areas of sector and core

governance, there were setbacks (amendments to the Telecommunication Act and proposed changes to

the Anti-Corruption Commission Act). Notable changes include:

Nominal protection reduced. The FY11 budget reduced the nominal protection rate from 23.9

percent in FY10 to 22.1 percent. For the most part, customs duties from previous budgets are

unchanged. In the energy/power sector, capital machinery, textile machinery and some industrial raw

materials, duties have been reduced.

Industrial Policy 2010-2014 approved. The new industrial policy, approved by the Cabinet in

August, emphasizes the importance of small and medium enterprises, and redefines micro industries

to enable them to avail facilities to meet their special needs. It also stresses the importance of a wide

range of industries, including agro-processing, shipbuilding, solar power, ICT products and services,

tourism, light engineering, herbal medicine, and energy efficient appliances; human resource exports

are also stressed. To encourage FDI, it is proposed that foreigners will be given five-year multiple

visas instead of a three-year multiple visa. It stipulates that industries cannot be set up using

agricultural land, cutting hills and hillocks, by filling rivers, canals or any other natural water bodies.

There is also a shift from the „policy of privatizing public sector industries‟ (industrial policy of 2005)

in favor of making them „competitive and profitable.‟ A legal framework will be provided for the

operation of sick industries which, among other things, will stipulate alternative employment for

those to be retrenched.

Special Economic Zone Bill passed. The Bangladesh Economic Zone Bill 2010 was passed by the

parliament on July 20, 2010. The proposed special economic zones will be set up in Sylhet, Feni, and

Khulna districts. According to the bill, there will be four types of economic zones – economic zone

by local or foreign nationals; private economic zone by local or expatriate Bangladeshis or foreigners;

government economic zone; and specialized economic zone for specialized industries with private or

public-private partnership or government initiative;

Public-Private Partnership (PPP) policy guidelines approved. In August 2010, the cabinet

approved the creation of a separate and autonomous office to deal with PPP projects, and finalized the

PPP guidelines under which private investors can place ”unsolicited” proposals before a ministry for

8

approval of projects without tender. This, the government hopes, will speed up negotiations with

private sponsors and award contracts of the PPP projects on a fast track after the submission of

proposals. The government's participation in the PPP projects would be through technical assistance

financing, viability gap financing and infrastructure financing. It has earmarked a Tk.30 billion fund

in the budget for several projects under the PPP. Private investors and non-resident Bangladeshis will

get special fiscal benefits in these PPP projects.

Bangladesh Infrastructure Finance Fund established. The cabinet has approved a proposal to form

the Bangladesh Infrastructure Finance Fund Ltd on July 29, 2010, to attract local and foreign

investments through internationally-practiced financing options, such as issuance of bonds and debt

instruments and equity offerings. The authorized capital of the company is Tk.100 billion and paid-up

capital will be Tk.16 billion. The government will hold 100 percent ownership of the company

initially, but the private sector will be able to obtain ownership through equity investment. The tenure

of the company will be 12-14 years, after which it will be liquidated. It is expected that the formation

of the fund will reduce the uncertainty regarding investment in PPP projects. In the current fiscal

year's budget provision was made to whiten black money by investing in the fund through payment of

10 percent tax.

Law enacted for fast track procurement of energy contracts. Parliament passed the Speedy

Supply of Power and Energy (Special Provision) Bill, 2010 in October. The law was enacted to

enable the government to take quick and effective action for supply, distribution, transmission,

transportation, marketing, and import of power and energy as well as exploration and extraction of

mineral resources. The bill provides blanket immunity to stakeholders acting in good faith. The law

will also get precedence over other acts including the Public Procurement Act 2006, should any

conflict arise. It will remain effective for two years.

Capital market regulations tightened. Firstly, the BB has restricted financial institutions‟

investments in the capital market to 25 percent of their equity (paid-up capital and reserves).

However, the financial institutions will be able to invest up to half of their paid-up capital, subject to

permission from the Bangladesh Bank. Secondly, the BB set a capital-market exposure limit for the

commercial banks under which banks would not be allowed to invest more than 10 per cent of their

total liabilities in the capital market. Furthermore, the banks would not be allowed to conduct

merchant banking or brokerage business without formation of subsidiary companies for that purpose.

Thirdly, the Securities and Exchange Commission (SEC) has asked the stockbrokers and merchant

banks to follow a net asset value (NAV) calculation for determining new margin loan, at ratio of 1:1,

and later extended the margin loan adjustment period to October 15, 2010. Fourthly, the SEC

increased the margin loan limit for mutual funds from 15 percent to 50 percent of NAV from

September 2, 2010.

Anti-Corruption Commission (ACC)’s autonomy proposed to be curtailed. In April 2010, the

cabinet approved proposals to amend six clauses of the 2004 ACC Act, to limit the commission's

autonomy. The proposed amendments include: provisions to require the ACC to obtain government

permission before filing graft cases against bureaucrats; making the ACC accountable to the

President; introducing penalties for filing false cases; and empowering the government to appoint the

ACC secretary. The proposed amendments have not yet been tabled in the parliament.

Bangladesh Better Business Forum abolished. The government dissolved the Bangladesh Better

Business Forum on August 19, 2010. The forum was formed in November 2007 with members from

top tiers of the government and private sector, amid reports that low business confidence had put

strains on the economy during the early days of the caretaker government.

9

Telecommunication Act amended. In July 2010, the parliament passed a bill amending the

Bangladesh Telecommunication Act 2001. The bill curtails the Bangladesh Telecommunication

Regulatory Commission (BTRC)‟s jurisdiction to issue licenses and fix tariffs. From now on, the

BTRC will have to seek prior permission from the government to issue licenses and fix tariffs. The

amendment also sets fines or imprisonment of up to 10 years, or both, for conducting business

without a license, violating the licensing conditions, and using telecoms equipment to work against

national sovereignty. Telecom operators and ICT-based companies can file appeals only against fines

imposed by the BTRC, but not against any other action of the government or the telecoms regulator.

The amendment has paved the way for legalizing voice-over-Internet protocol (VoIP) business and

issuing VoIP call termination operator licenses to generate employment. The Bill also makes

provision for raising a "Social Obligation Fund" for expansion of the telecoms network in remote

areas.

Outlook for FY11

Global recovery likely to be sustained, though uneven The World Economic Outlook Update (July 2010), forecast that the global economy will see modest

recovery of 2.5 percent in advanced countries in FY11, with considerable variation between

individual countries. The challenges to recovery in the advanced countries would come from the buildup

of high levels of public debt, rising unemployment and constrained bank lending. Growth prospects could

be further undermined if severe or poorly planned fiscal consolidation further constrains domestic

demand. In addition, risks could emanate from uncertainty about regulatory reforms and their impact on

lending and economic activity. Developing and emerging economies are expected to grow faster, at

around 6.5 percent, with variation among individual countries. However, the update warns of greater

downside risks to global growth: heightened risks of financial stress and contagion could lead to increases

in funding costs, weaker banks, and therefore a tightening of lending conditions, and weaker consumer

and business confidence. With the trade-financial linkages, this could lower global demand.

GDP growth in Bangladesh is projected to reach between 5.8 and 6.1 percent in FY11 GDP growth is projected to be 6.1-6.3 percent in FY11, up slightly from 5.8 percent in FY10 (Table

1). The estimate emanates largely from higher public and private investment as well as increased capacity

utilization due to a rebound in exports. Public investment will rise if the recently approved Policy and

Strategy of PPP 2010 starts yielding results and ADP implementation continues to improve. Private

investment will rise if the supply side constraints, particularly energy, are eased. Towards the end of

FY10 and into the first quarter of FY11, exports started showing signs of strong recovery.6 In response,

industries are borrowing from banks to expand operations and install generators to cope with the power

crunch, and LC opening for imports of capital machinery has risen in jute, textiles, garments,

pharmaceuticals and plastic industries.

6 Exports in the first quarter of FY11 grew by 29.9 percent. Given this, exports need to grow by only 9.2 percent in

the remaining three quarters to achieve the government‟s target of 14.2 percent export growth in FY11.

10

Table 1: GDP Growth

Growth in constant prices (Percent)

Actual

Provisional

Estimate Projection

2007 2008 2009 2010 2011

GDP 6.4 6.2 5.7 5.8 6.1 - 6.3

Private Consumption 5.9 5.5 5.9 5.5 4.5

Government Consumption 6.4 3.6 5.9 9.2 10.2

Gross Fixed Investment 8.7 -0.7 6.2 8.1 8.5 - 9.1

Exports, GNFS 13.0 7.0 0.0 5.0 8.5 - 10.0

Imports, GNFS 16.0 -2.1 -2.6 4.0 7.0 - 8.0

Source: BBS Data and WB Staff Estimates.

However, several downside risks remain, which could drive growth below the range projected for

FY11 above. Chief among the risks are: Weaker-than-anticipated global recovery; a larger-than-

anticipated slowdown in remittances because of fewer people going abroad; and continuing power

shortages. The growth of countries to which Bangladesh exports its goods and people will continue to

affect its overall growth performance. For instance, if the US and EU economies stall more than

projected, Bangladesh exports would drop. Similarly, if the destination countries of the Gulf region that

attract Bangladeshi migrants recover slowly, remittances to Bangladesh would slow.7

On the domestic front, electric power is among the major factors affecting growth prospects for

FY11. Bangladesh is currently facing 1,500-2,000 MW of power shortages during peak hours. The 2007

Investment Climate Assessment notes that severe power shortages are a major constraint on industry –

estimates put the cost of electricity shortages at as much as two percentage points of annual GDP growth.

Recognizing the need for ensuring uninterrupted power supply to industries in the short run, the

government has signed several new contracts to purchase power from private companies. These

agreements are expected to add around 1,300-1,500 MW of electricity to the national grid during FY11.

While the new power purchase agreements will ease the energy shortages that constrain growth,

they will strain the fiscal situation. Electricity tariffs in Bangladesh are set below cost-recovery levels.

In FY09, the Bangladesh Power Development Board (BPDB)‟s effective tariff – calculated by dividing

the revenue from energy sales by the volume sold – was Tk.2.68/kWh, equivalent to US¢3.9/kWh. The

gap between wholesale purchase prices (at which the BPDB agreed to purchase electricity from the

private companies, based on the new contracts)8 and administered tariffs will require fiscal transfers. This

will add to the transfers that the BPDB, and the Bangladesh Petroleum Corporation (BPC), already

receive to cover part of their losses. The wholesale purchase price of power will reportedly range between

Tk.8/kWh and Tk.14/kWh. In addition, all these new plants are going to be powered by diesel and furnace

oil. The BPC will have to import more refined products to meet the growing demand from the new oil-

fired power plants. It appears that BPC will make imported diesel and furnace oil available to the private

companies at subsidized prices.9 Consequently, the country‟s demand for fuel oils (to be met by the BPC)

would rise as the contracted plants go into operation. In the absence of domestic oil price adjustments, the

7 Remittances in the first quarter of FY11 declined by 2 percent.

8 The expected completion time of the construction of each plant is provided in the Towards Revamping Power and Energy

Sector: a Road Map, June 2010, available at www.mof.gov.bd. 9 The New Age, Fuel price hike is on the cards, August 10, 2010.

11

BPC will make a larger loss in the near-term, particularly now that global oil prices are higher than the

levels of the past year.

The new power purchase agreements will put additional strain on public finances as the providers

start supplying power to the national grid. Regardless of how resources are transferred – be they

explicit, implicit or quasi-fiscal transfer – the costs of the new agreements will have to be borne by the

government eventually. The potential fiscal costs associated with the new power purchase agreements are

estimated in the Tables below, assuming that there are no retail or bulk tariff adjustments. In the absence

of detailed information on the new contracts, the results should be taken only as indicative of the fiscal

burden likely to arise as the new contracts become operative.

The additional fiscal costs of the new power purchase agreements are shown in Table 2 and could

range between Tk.32 billion and Tk.72 billion in FY11 (compared to Tk.9 billion in FY09), depending

on the volume of electricity added to the national grid during the year, and the average wholesale tariff of

electricity purchased by the BPDB. Losses arising from the new power purchase agreements are

calculated as Volume, in GWh (average wholesale tariff-retail price: see Table 2 note * below).10

These

estimated fiscal costs arise directly from the new power purchase agreements and are in addition to the

losses BPDB makes from existing arrangements (IPPs and rentals).

Table 2: The BPDB’s Estimated Additional Fiscal Costs in FY11*

Billions of Taka (as percent of projected FY11 Revenue**)

MW

BPDB's Purchase Price (Taka per kWh)

10.0 11.0 12.0 13.0 14.0

1000 -32.2 -36.6 -41.0 -45.4 -49.8

(3.5) (3.9) (4.4) (4.9) (5.4)

1100 -35.1 -39.9 -44.7 -49.5 -54.3

(3.8) (4.3) (4.8) (5.3) (5.8)

1200 -38.0 -43.2 -48.4 -53.6 -58.8

(4.1) (4.7) (5.2) (5.8) (6.3)

1300 -41.0 -46.6 -52.2 -57.8 -63.4

(4.4) (5.0) (5.6) (6.2) (6.8)

1400 -43.9 -49.9 -55.9 -61.9 -67.9

(4.7) (5.4) (6.0) (6.7) (7.3)

1500 -46.8 -53.2 -59.6 -66.0 -72.4

(5.0) (5.7) (6.4) (7.1) (7.8)

* Assumes weighted average tariff of Tk.2.68/kWh. The estimates exclude additional wheeling charges BPDB

will have to pay for new power purchase agreements. The calculations pertain to a full fiscal year. Thus, actual

losses will need to be computed on a pro-rata basis, based on when the new capacity actually comes on stream,

and depending on the actual mix of furnace oil and diesel-based capacity.

** Projected Revenue-GDP Ratio for FY11 is 11.9 percent.

The new power purchase agreements would also increase the BPC’s fuel import bill, depending on

the developments in international commodity markets and the growth in domestic demand. The

10 The additional capacity is assumed to be phased in incrementally. The first column in Table 2 takes account of the fact that 100

MW has already been added in FY11 and the rest of the quantity is assumed to be reached by adding to the national grid an equal

quantity every month, starting in September. For example, the 1500 MW should be read as 100 MW already added, plus 140

MW to be added every month from September onwards.

12

additional fuel import bill to the BPC from the new power purchase agreements would range from

US$219 to US$393 million (see Annex 2), and additional losses to the BPC could range from Tk.5.3 to

Tk.12.9 billion (Table 3).

Table 3: Estimated Additional Impact on the BPC’s Finances

(Billions of Tk.)

MW

International Crude Oil Prices (US$/barrel)

75.0 80.0 85.0 90.0 95.0

1000 -5.3 -6.2 -7.1 -8.0 -8.9

1100 -5.8 -6.8 -7.7 -8.7 -9.7

1200 -6.3 -7.3 -8.4 -9.4 -10.5

1300 -6.8 -7.9 -9.0 -10.2 -11.3

1400 -7.2 -8.5 -9.7 -10.9 -12.1

1500 -7.7 -9.0 -10.3 -11.6 -12.9 Source: WB Staff Estimates.

The overall fiscal implications (for both the BPDB and the BPC) of the new power agreements are

therefore significant. Furnace oil-based power is likely to be the dominant source of additional power in

FY11. According to BPC data, its share could vary between 66 percent and 70 percent, the rest coming

from diesel-based power. Given that the former will be purchased at Tk.8/kWh and the latter at

Tk.14/kWh, the plausible weighted average power purchase price is projected to range between Tk.9.8

and Tk.10.1/kWh. Assuming an average oil price of US$80 per barrel, and that 1400 to 1500 MW will be

added, the plausible estimate of losses for the BPDB is Tk.43.9-46.8 billion and for the BPC, Tk.8.5-9

billion. That would have an overall fiscal impact of between Tk.52.4 billion and Tk.55.8 billion;

equivalent to 5.6-6.0 percent of the FY11 budget revenue target, and about 0.67-0.72 percent of GDP.

There is some fiscal space to absorb the additional fiscal burden arising from the rental power

purchase. Assuming that GDP growth is maintained at 5.5 percent or above in FY11 and that the

effective nominal interest on public debt does not rise above 5 percent, Bangladesh can afford to raise the

primary deficit to 4.3 percent of GDP while keeping the debt/GDP ratio at the current sustainable level of

43.7 percent. The projected primary deficit for FY11, including the fiscal costs of rental power purchase

is 3.7 percent of GDP. Thus, the additional fiscal burden still keeps the primary deficit within a

sustainable level.

As an emergency response to the power crisis, the rental power purchase agreements are

appropriate. If the agreements succeed in delivering power to the national grid, a major constraint on

economic growth will be eased.11

However, as shown above, success in the provision of rental power will

create fiscal pressure if retail power prices are maintained at their current levels. The government has the

fiscal space to accommodate these pressures without cutting critical social and infrastructure expenditures

– if it can ensure that the FY11 revenue collection is close to the target. For the medium and longer term,

cheaper measures must be explored. A good start would be to retrofit the existing twelve old and

inefficient power plants that could yield 650 MW over 6-12 months and to import power from India. The

government is also speeding up implementation of ongoing longer-term interventions such as the

Siddhirganj power plant. In addition, the longer-term options identified in the government's road map to

replace rental power (coal policy, policy on offshore gas exploration, extraction of remaining gas from the

11

This assumes that net power generation increases as a result of the new agreements, i.e., gas shortages or plant

tripping do not negate the additions to power arising from the new plants.

13

existing gas fields) should be carried out as scheduled, if not faster. Finally, the sector‟s financial health

needs to be restored in order to provide the right incentives for private investment.

Fiscal pressures could grow in FY11 if food prices continue to rise

The recent global staple price increases could put further pressure on food prices in Bangladesh in

FY11. According to the Food Price Watch (September 2010), since mid-June, global grain prices have

been rising with a 56 percent rise in global wheat prices and knock-on impacts on other commodities,

such as rice, maize, and sorghum. Given its burden of poverty and malnutrition, food price spikes are of

special concern in Bangladesh. A 2008 survey shows that rising food prices have a significant impact on

the consumption patterns of the poor.12

The government‟s policy response so far has included

participation in food grain markets, expanded operations of the existing safety net programs, and

incentives for increasing rice production. These measures, together with higher imports to build up stocks

for the food grain distribution system, could have fiscal implications beyond the amounts provided in the

FY11 budget for public food distribution operations, especially if the situation deteriorates.

12 World Bank (2008). “A Food Crisis Development Support Credit.”

14

Annex I: Inflation Trends and Policy Response: A More Detailed Look

Recent trends Annual inflation

13 increased from 6.7 percent in FY09 to 7.3 percent in FY10, while remaining

volatile at around 7.5 percent in July-August 2010. The sharp rise in inflation was driven mainly by

increases in food inflation, from 0.3 percent in June 2009 to 10.9 percent in June 2010. Rural food

inflation stood at 10.4 percent and urban food inflation reached 12 percent in June. The food price index

was driven, in turn, by a rise in the price of rice that has 23.8 percent weight in rural CPI and 11.3 percent

weight in urban CPI. Rice alone contributed 8.1 percentage points to rural inflation (which was 9.9

percent) and 3.1 percentage points to urban inflation (which was 8.9 percent) in August 2010.

Overall inflation in Bangladesh tends to follow global trends moderated by the domestic supply

situation. Bumper food production coupled with falling global prices led to a decline in inflation in

Bangladesh from September 2008, when the twelve-month moving average inflation rate reached as high

as 10.1 percent and food and non-food inflation rates were 12.6 percent and 6 percent respectively. After

a respite of about one year, inflation began rising from October 2009, driven mainly by the rise in food

inflation. Inflation peaked at 9 percent in January-February 2010 and then declined erratically to 7.5

percent in August 2010.

A monthly trend analysis of prices at the individual commodity level indicates that: (a) the rice price

increased sharply in both rural and urban areas; (b) prices of pulses and garlic have increased sharply in

the last twelve months in both urban and rural areas; (c) the price of mustard oil has been stable in both

rural and urban areas in recent months; (d) onion prices have been generally volatile, though declining

sharply in both rural and urban areas since October, 2009; (e) the sugar price increased significantly from

June 2009 and stabilized at the higher level from October 2009; and (f) potato prices declined, as usual,

during the harvest season of December to February.

Prices in Bangladesh are affected by price developments in the international market, especially

food prices in India. India has been experiencing double-digit food inflation since June 2009, and that

13 Inflation/price changes are year-on-year unless otherwise stated.

Retail

Wholesale18

24

30

36

Jun

-07

Sep

-07

Dec

-07

Mar

-08

Jun

-08

Sep

-08

Dec

-08

Mar

-09

Jun

-09

Sep

-09

Dec

-09

Mar

-10

Jun

-10

Figure 1: Retail & Wholesale Price of Coarse Rice in Dhaka (Taka per Kg)

200300400500600700800900

1000

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Figure 2: Price of Rice (Thailand, 5%) $/mt

15

contributed to food inflation in Bangladesh. On the domestic front, Aman (second largest rice crop)

production was 4.2 percent (0.5 million metric ton) lower than target. A firm estimate for Boro (largest

rice crop) production is still not available (the BBS estimate puts it at 17.4 million tons - 2.2 percent

lower than last year, while the Ministry of Agriculture projects that it has exceeded the target of 19

million tons). The recent global staple price increases raise the risk that domestic food prices will spike

further in the coming months.

Non-food inflation increased from 3.7 percent in July 2009 to 7.0 percent in December 2009 before

gradually dropping to 3.8 percent in August 2010. Rural non-food inflation stood at 3.8 percent while

urban non-food inflation reached 3.6 percent in August. The declining trend in non-food inflation cannot

be taken for granted. In FY10 broad money grew by 22.4 percent, the highest growth in 17 years.

Although declining, the liquidity overhang persists; excess liquidity in the banking system amounted to

Tk 299 billion at end-August 2010 compared to Tk.345 billion at end-June 2010.

Policy response Domestic agriculture output and world food prices, particularly prices in India, are likely to have a

strong bearing on food inflation in the next few months. The Bangladesh Bank has reduced the

maximum repayment time of revolving overdraft loans taken against “pledge and hypothecation” for rice

procurement from 60 to 45 days for local rice millers and from 45 to 30 days for rice traders, to ensure

adequate supply. The government has also decided to import 130,000 tons of rice from Thailand,

Pakistan, Vietnam and India to boost official stock. At present, the stock of rice is around 750,000 tons.

The government is also planning to stop the “delivery order” system, as this is partly responsible for

raising the price of essential items, and has extended the export ban on both aromatic and non-aromatic

rice to December 2010.

The government has also taken several measures to tackle the price hike. These include active

participation in the food-grain market, expanded operations of the existing safety net programs, and

provision of incentives for increasing rice production. It also imports wheat and rice from world market to

build a stock with which to operate a public food-grain distribution system.

The government has decided to scale up the Public Food Distribution System in FY11, and has

made adequate allocation for this in the Budget. In order to increase the stock, the government aims to

procure 1.5 million tons of rice from the domestic market and import rice and wheat. The procurement

price was fixed at Tk.18/kg for paddy and Tk.28/kg for rice. The government also intends to increase

storage capacity for food-grains by 400,000 tons.

The government is providing special support to boost agricultural production. The Bangladesh Bank

issued a directive to commercial banks to increase disbursement of agricultural credit, targeting areas

affected by the floods and cyclones. The disbursement of agricultural credit increased by 19.7 percent in

FY10 compared to FY09. The government also maintained subsidies on chemical fertilizers and diesel for

irrigation, despite the increased prices of the inputs in world market.

The Bangladesh Bank has taken several measures to check inflation. It increased the Statutory

Liquidity Requirement by a 0.5 percentage point to 18.5 percent from May 15 2010, and the repo rate

from 4.5 percent to 5.5 percent and reverse-repo rate from 2.5 percent to 3.5 percent from August 19

2010. It also instructed banks to channel credit to productive sectors of the market only.□

16

Annex 2: Estimated Additional Fuel Import Bill of the BPC (Millions of US$)

MW

International Crude Oil Prices (US$/barrel)

75 80 85 90 95

1000 219.2 231.9 244.7 257.5 270.3

1100 239.1 253.0 266.9 280.9 294.8

1200 259.0 274.1 289.2 304.3 319.4

1300 278.9 295.2 311.4 327.7 343.9

1400 298.8 316.2 333.7 351.1 368.5

1500 318.7 337.3 355.9 374.5 393.0 Note: In taka, the additional fuel import bill could range between Tk.15.3-27.3 billion.